This market-timing strategy uses the implied volatility index as an indicator to predict future stock market return. In this strategy, stocks are supposed to be sold when the indicator rises above the predefinded threshold value, and vice versa. It also has “delay day” and “waiting day” settings.
The risk-return theory argues that, under certain conditions, the market risk premium is positively correlated with the variance of the market portfolio. French, Schwert, and Stambaugh (1987) find that, if there is an unexpected increase in market volatility, expected volatility is revised upward for future periods. Hence, given that the market risk premium is positively related to the expected volatility of the market portfolio, discount rates will increase and in turn reduce stock prices. Thus, a negative relation between (unexpected) volatility changes and returns is induced. The performance of timing rules based on volatility changes has been investigated, for instance, by Copeland and Copeland (1999), who test the feasibility of market timing based on changes in the implied volatility index, VIX, and find profitable strategies.
In this Strategy, for the implied volatility index, falling below a certain threshold is considered to be a switch signal from holding cash to investing in S&P 500 Index, and vice versa. If the same switch signal persists for “delay days”, we switch the trading position. And in the succeeding “waiting days” we keep the position ignoring the new switch signals. The signals are examined every trading day.
VIX is used as the implied volatility index. The threshold can set to be certain fix values or SMA (Simple moving average) of certain days. And the Portfolio StartDate should not be set to the date earlier than 01/02/1990 due to lack of data.
Parameters used in the created portfolio:
Indicator: VIX (implied volatility index)
TresholdValue: 15, 30, SMA 30days (default), SMA 120days
WaitingDay:1 day, 5 days (default)
DelayDay: 1 day, 5 days (default)
BuySecurity: ^GSPC (default)
Similar Strategies in ValiFi:
- Market Timing Rule with Short Term Interest Rate: using the short-term interest rates as an indicator
- Market Timing Rule with Maturity Spread: using the spread of long-term and short-term interest rates as an indicator
- SMA Timing Method proposed by Faber: using the SMA of the target asset as an indicator
- High Yield Bond Timing Strategy: using trend triggers (percentages from recent high or recent low) of the asset price for buy and sell decisions
- The 125 05 Timing Model of High Yield Bond Strategy by Gerald Appel: using predifined trend triggers (percentages from recent high or recent low) of the asset price for buy and sell decisions
- Market Timing Rule with Long Term Interest Rate: using long-term interest rate as an indicator
- Market Timing Rule with Earning to Price Ratio: using the E/P ratio as an indicator
- Market Timing Rule with Dividend Yield: using the dividend yield as an indicator
- Market Timing Rule with Expected Inflation: using the expected inflation as an indicator
- Market Timing rule with Implied Volatility Index : using the implied volatility index as an indicator
- Market Timing Rule with Bond-Equity Yield Ratio : using the bond-equity yield ratio as an indicator
- Market Timing Rule with Dividend Payout Ratio : using the dividend payout ratio as an indicator
- Market Timing Rule with Credit Spread : using the credit spread as an indicator
- Market Timing Rule with Put/Call Ratio: using the put/call ratio as an indicator
- Learning Market Timing Rule: following the most profitable rule of the above simple market rules in each period
- Voting Market Timing Rule : Switching the position if a certain percentage of the above simple market timing rules intends to do so.
See Also
Relative Working Papers:
- Neuhierl, Andreas, Schlusche and Bernd. Data Snooping and Market-Timing Rule Performance. 2009.
- French, Kenneth R., G. William Schwert and Robert F. Stambaugh. Expected Stock Returns and Volatility. 2007.
- Copeland, Maggie M. and Thomas E. Copeland. Market Timing: Style and Size Rotation Using the VIX. 1999.
- Fleming, Jeff, Chris Kirby and Barbara Ostdiek.The Economic Value of Volatility Timing Using `Realized Volatility'. 2003.
- Christoffersen, Peter F. and Francis X. Diebold. Financial Asset Returns, Direction-of-Change Forecasting, and Volatility Dynamics. 2006.
Relative books:
- Deborah Weir. Timing the Market: How To Profit in the Stock Market Using the Yield Curve, Technical Analysis, and Cultural Indicators . 2000.
- Les Masonson. All About Market Timing: A Easy Way To Get Started. 2003.
- Colin Alexander. Streetsmart Guide to Timing the Stock Market: When to Buy, Sell, and Sell Short. 2005.